The Next Phase Of Innovation: Rethinking The Business Model
BY KENNETH CLINE
Products, services and markets innovation are a given. Bank shareholder value creation will increasingly depend upon new ways of doing business and collaborating, say IBM consultants.
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SYNOPSIS | IBM's recent Global CEO Survey finds bank CEOs increasingly thinking about business model and operations innovation. IBM researchers expect banks to continue on the "treadmill" of products, services and markets innovation but focus on applying their core competencies to other industries and partners. Umpqua Holdings Corp., Commerce Bancorp, Citigroup Inc., Bank of America Corp., HSBC Holdings plc and Royal Bank of Scotland are among innovators cited.
Across the globe and across all industries, the drive to innovate is becoming a top-of-mind issue, according to recent research by Armonk, N.Y.-based IBM Corp. IBM's latest Global CEO Survey, released in March 2006, finds that 65% of the world's top corporate CEOs plan to radically change their companies. Responses from 84 bankers were included in the survey of 765 CEOs, and one out of every two bankers said they anticipated fundamental change in their business environment in the next two years.
This marks a shift in focus, according to IBM consultants Sunny Banerjea and Shankar Ramamurthy. Previous bank innovation has centered on products, services and markets (PSM), but these surveyed CEOs are displaying an interest in more far-reaching business model and operations innovation. As Ramamurthy puts it, “Commoditization and the similarity of products and lack of pricing power are strong indicators that the current approach isn’t working.”
Unlike some industries that are accustomed to periodic radical revamping of their business models and operations, this suggests a significant disruption. What will it mean? Banerjea expects banks to begin applying some of their core competencies, such as risk management, payments and data analytics, to other industries, such as health care. Both researchers foresee heightened collaboration between banks and their suppliers to spur innovation.
Banerjea is Global Banking Industry Leader, Institute for Business Value, and Ramamurthy, Global Practice Leader, Financial Services Sector Strategy and Change, at IBM Global Business Services. Banerjea is based in Plano, Tex., and Ramamurthy in New York City.
Q: What are the origins of your Global CEO Survey?
Ramamurthy: Every couple of years, we look at the top-of-mind issues for CEOs on a worldwide basis. Rather than have a completely open dialogue, we tend to pick issues that may be relevant for the CEOs. And this year, the CEO survey was structured around innovation.
Q: Why pick innovation this year?
Ramamurthy: A couple of years ago, in a survey, we were getting early signals that innovation was starting to become a top-of-mind issue. Everybody recognizes that the traditional product- and service-based innovation models are becoming commoditized, meaning becoming easily copied.
An interesting thing about doing these CEO surveys is you only get dialogue if you’re presenting issues that are top-of-mind to them. And this year, we had more CEOs participating than ever before.
Q: Regarding the responses from the 84 bankers specifically, how did they feel about innovation and its role in the financial services industry?
Ramamurthy: Inherently, financial services enterprises tend to be slightly conservative compared to some other industries, and for legitimate reasons. If you’re in telecommunications or in electronics, fundamental change is the order of the day. The results from the CEO survey tend to accentuate that.
In financial services, particularly in banking, our clients tend to think about innovation primarily around products, services and markets (PSM), rather than having to fundamentally rethink their operations or business models. It’s just the nature of the sector.
Q: Do you see that as a problem? Should banks look more at operations and business model innovation?
Ramamurthy: “Problem” is perhaps too strong a word. The banking industry, globally, is making healthy profits right now. But banks are facing issues like consolidation in multiple markets, including the U.S. For the first time, we’re seeing business model and operations innovation within the banking industry become more prominent.
Two years ago, this was not top-of-mind. Now our clients are recognizing that PSM innovation is not giving them sustained competitive advantage. Doing more of the same is not necessarily going to give them the competing objectives of growth, differentiation, efficiency, flexibility and resiliency. Commoditization and the similarity of products and lack of pricing power are strong indicators that the current approach isn’t working.
Q: What metrics do you use to measure business model and operations innovation?
Banerjea: One of the things we continuously say is that at the end of the day, measuring the success of innovation has to result in a transparency that flows through the obvious metric, which is increasing shareholder value. What we have found in successful organizations that are trying to have enterprise-wide innovation is that 1) there is support from the top, 2) it is being measured by a metric at the operational level and 3) people are being rewarded for tracking and meeting those metrics.
One of the most common metrics used to track efficiency at the operational level is obviously the efficiency ratio. Of course, that has to be used in an appropriate manner, given the mix of the bank’s revenue stream.
Q: Some bankers say focusing on the efficiency ratio tends to have a chilling effect on revenue growth from innovation. Do you agree?
Banerjea: Clearly, as with anything, there must be balance. We feel that it is possible to have a low efficiency ratio and still have market-leading capabilities that can translate into high customer differentiation. Efficient processes designed to meet the needs of a bank’s target set of customers can have a very positive impact on operating margins and customer satisfaction.
Measuring the effect of innovation is difficult and one needs to be very careful as to how this is done — an overemphasis on metrics can stifle creativity, as in many instances we’re dealing with cultural change.
Q: How did the bankers in the survey feel about operational or business model innovation?
Banerjea: When they were asked about their top innovation priority, 63% of them were focusing on PSM. It’s not as if PSM innovation is going to go away. If a competitor comes up with a new product or service, you’ve got to come up with something similar. And so, most banks are on that treadmill, to avoid churn in their customer base. Across all industries, people recognize that PSM innovation is a given.
But for the first time, we see business model and operations innovation being taken a lot more seriously. There are a material number of CEOs, from a statistical standpoint, who are saying those things are important. There is a recognition that banks need to be rethinking their business models.
Q: Can you elaborate on what you mean by business model innovation?
Banerjea: Extending core banking capabilities such as credit risk management to receivables management, retail payment processing capabilities to health care payments processing or hedging capabilities to other industries are good examples of extending beyond a bank’s traditional business model and can be considered a business model innovation.
Q: What could motivate a bank to change its business model?
Ramamurthy: We’ve done a fair amount of work for ourselves and our clients on how this plays out.
Look at the mortgage business, where there’s been a deconstruction in the value chain so that companies now specialize in various aspects of that chain, such as mortgage servicing, credit risk management, interest rate risk management, etc. And the banks that took a proactive position in that deconstruction by rethinking their business models have really recognized a lot of shareholder value.
We’ve seen this time and time again, as in securities processing. Small, niche players who don’t even have banking charters are able to come into these businesses with new business models to create extraordinary shareholder value. Fair Isaac Corp., for example, has gotten into the heart of credit decisioning in virtually every credit card decision that happens in the world. And yet, you’d think of credit decisioning as a core competency of banks.
So you’re seeing innovation happen and you’re seeing shareholder value creation disproportionately accrue to players who are able to stay on the cutting edge of that innovation.
Q: How does collaboration, or seeking out external ideas, help the innovation process? Your data shows that banking lags other industries in this area.
Banerjea: In other industries, you see people reaching out and connecting with their suppliers, and I think with their customers, a little more than in banking. In the software industry, for example, you see more collaboration given the open source approach.
Ramamurthy: When the business ecosystem forces behavioral change, collaboration will happen a lot more easily than when the industry is making good profits. Today, in the banking ecosystem, profit is not an issue. But the CEOs are worried about change, and as they look forward to the next couple of years, they can see an increased need for collaboration. It’s not optional.
Banerjea: In the next several years, we think you will see collaboration happening in adjacent areas like health care payments. Increasingly, you will see some smart innovators in the banking world stepping in and taking out the high cost of payments processing, enabling payments between hospitals and their suppliers. They could also insert a high degree of credit risk management between hospitals and their patients, which is lacking in that industry right now.
One should focus on identifying where banks can generate additional revenues by leveraging their core capabilities into adjacent spaces. Which other industries could benefit from banks’ advantage in areas such as data analytics, risk management and payments?
Q: But what about collaboration within the banking industry? Is that a possibility as well?
Banerjea: Establishing a mortgage hub, sharing of credit portfolio data and account opening shared centers are all powerful areas for collaboration between and within banks.
Q: Can you cite any current examples of collaboration in banking?
Banerjea: There’s Royal Bank of Scotland’s (RBS) distribution relationship with the Tesco retail chain in the U.K. and GE Money’s credit card partnership with State Bank of India. Domestically, we’d point to the agreement between Citigroup Inc.’s Citibank subsidiary and 7-Eleven, which provides surcharge-free ATM usage to Citibank customers at more than 5,500 stores in 31 states through Citibank-branded ATMs. NetBank Inc. has partnered with UPS stores, which serve as collection points for its customers’ deposits.
Emerging standards (e.g., MISMO in mortgages) around key banking processes such as mortgages, payments and account openings will foster greater collaboration in the banking ecosystem and also internally as banks start specializing and organizing themselves around manufacturing, distribution and processing competencies. Innovative collaboration will help distinguish the smart value creators from the cautious followers.
Q: Which banks seem to be managing innovation better than others? And what is the secret to their success?
Banerjea: There should be strong recognition at the enterprise level of the importance of innovation in creating sustainable value for the institution that decides to embrace it as a strategic lever and differentiate itself from the pack.
Look at what Portland, Ore.-based Umpqua Holdings Corp., for example, is trying to do. We’ve been observing them for the past three years. They don’t stop at just one thing, like going to Ritz-Carlton for help on their service capabilities. They did quite a few things that together helped create a powerful differentiated customer experience.
And that we find is what differentiates organizations that pay lip service to innovation and others that take it so seriously that they do a series of things that build on each other. It makes it that much more difficult for the competition to copy. People can see it but they can’t immediately replicate it.
Commerce Bancorp of Cherry Hill, N.J. has created a convenience niche for themselves. While others could easily have done it, they said, we’re going to brand ourselves as the most convenient bank. They did that very successfully by extending hours and by implementing a series of innovative initiatives. You have to build a portfolio of innovative initiatives. Quite a few of them will fail, but some will be successful and create enormous value.
Among the larger banks, we still think of New York City-based Citigroup Inc. and Bank of America Corp., Charlotte, as being innovative, although in different ways. Citigroup’s American Airlines frequent flyer program, development of a global brand and leading use of technology infrastructure are some examples of a strong in-
novation heritage. Bank of America, through its highly successful free online bill payments offering, the very recent Keep the Change Cards program, and highly efficient processes in its cards area, continues to push the boundaries of innovation.
HSBC Holdings plc and RBS also come to mind. HSBC has innovated continuously across its payments processes focusing on resiliency and quickness and also around its product life cycle management processes resulting in significantly shorter launch cycles. RBS is one of the few banks to have organized around their clients and also specialized internally around manufacturing, distribution, and processing competencies and transforming itself into a highly efficient bank.
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